Answer to Question #185727 in Finance for Derrick

Question

You are required to:

1) Calculate the book value and market value cost of capital (WACC) for ABC plc. (35 marks)

2) Considering the proposed changes to ABC’s capital structure, recalculate the

organisation’s cost of capital to reflect these changes and comment on the CFO’s

forecasts. (35 marks)

3) Critically analyse whether you consider that organisations, by integrating a sensible level

of gearing into their capital structure, can decrease their WACC, ensuring the response integrates

relevant empirical research within this area of study. (30 marks)

Answer 1

1:Computation of WACC as per the book value (BV):

Hence, total BV is £50,000 and WACC for present BV structure is 18.25%

2:

Hence, WACC of new structure is 13.45%.

3:

CFO forecasts that WACC will be lower by issuing new debt which is right because debt is a cheaper source. As, cost of new debt (11% bonds) is less than the cost of ordinary or equity shares. And, ordinary shares will be repurchased through new debts, meaning the firm can save cost on £15 million but it will increase the risk factor.